Monday, March 9, 2009

Donald Kohn, vice chairman of the Federal Reserve, learned this week about blackmail, Senate style, when he refused to disclose the names of financial institutions benefiting from the bailout of American International Group.

Testifying about AIG (AIG, Fortune 500) before the Senate Banking committee, Kohn respectfully resisted all of its attempts to extract the names. Several committee members grew frustrated and finally got to the point of threatening Kohn with no more dollars for the credit crisis - ever - if he didn't spill the information.

Said Sen. Jim Bunning, R-Ky., "You will get the biggest 'no' you ever got. I will do anything possible to stop you from wasting the taxpayers' money on a lost cause."

Why so much fuss over these names? While the government has maintained that saving AIG was necessary to prevent an even wider catastrophe, senators contend the move has also bailed out counterparties who took unwise risks, so the legislators want to know who those companies are.

While The Wall Street Journal Saturday reported many of the names of the 25 counterparties involved, FORTUNE has independently obtained a somewhat different group of 15 names, listed in an intriguing order (see below).

The information that riled the Senate committee this week concerns about $80 billion of credit default swaps - contracts that insure investors against losing principal and interest - that AIG wrote on super-senior tranches of collateralized debt obligations (CDOs) that were backed by mortgage securities, some of them subprime. (See The Company that Came to Dinner, FORTUNE, Jan. 19).

When AIG suffered rating downgrades, the resulting collateral calls on the credit default swaps proved ultimately to be much more than AIG could handle and became the main reason the company was bailed out - with government commitments that now exceed $150 billion.

The counterparties to the swaps were 25 financial institutions spread around the world. Many of them would have been vulnerable to a domino effect if they hadn't received, first, the collateral AIG paid them and, later, billions of dollars from the U.S. government that made the counterparties whole.

In this whole disaster that began to play out last September, neither AIG nor the government has ever divulged the names of the counterparties - and that's what infuriates Bunning and other senators.

Committee chairman Christopher Dodd, D-Conn., describes the counterparties as less than "innocent victims" who used AIG's rating (then AAA) to take "enormous, irresponsible risks." He complains, "It is not clear who we are rescuing."

The Fed's Kohn argued that he couldn't give out the names because the counterparties had entered into contracts with AIG not expecting their identity ever to be disclosed. Naming them, he said, might deter them from doing business with AIG again.

In the end, however, Kohn said he would carry the committee's request back to the Fed and see what might be worked out.

A reliable source, however, has given FORTUNE a list of 15 counterparties, with no dollar figures attached. The list contained the names in the following order. FORTUNE sought comment from all of the financial institutions and none said their inclusion on the list was inaccurate.

What is the significance of the rank order of the list? Since it is not alphabetical, one possible interpretation is that the banks are listed in order of the amount of CDOs they insured with AIG.

Goldman Sachs' No. 2 position fits several press reports that it was an important counterparty, perhaps having insured $20 billion of CDOs with AIG. Goldman has never confirmed that figure, but it has said that its "net" exposure to AIG - after collateral it received and hedging it did - was minimal.

If indeed France's Société Générale ranks No. 1 by exposure, it's a distinction the bank certainly didn't need. Early last year, the company was staggered by the news that a rogue trader had lost $7.5 billion. Had a domino effect ensued from AIG's collapse, Société Générale would have been in an especially vulnerable position.

The Fed's Kohn admitted in the Senate hearings that paying off these counterparties in the course of the AIG rescue "will reduce their incentive to be careful in the future," which helps explain why the names have become such sought-after information in the political debate over "moral hazard."

A transcript of Thursday's hearings that was done by Congressional Quarterly contains a typo that nicely describes the whole disastrous mess that AIG has turned out to be for U.S. taxpayers. The speaker was New York superintendent of insurance Eric Dinallo, and what he said was, "AIG is a microcosm of our regulatory regime."

But the transcript says not "microcosm," but "microchasm." And that's what AIG has proved to be, a money pit of gaping proportions.

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